Fortune Favours the Brave

April 6, 2018

As today is National Tartan Day, I thought it suitable to reflect on two common Scottish references—bravery and independence.  In light of the further market turmoil created by the US Administration’s desire to risk a trade war and go after Amazon, investors are being tested in their ability to stand brave in the face of volatility, while the market itself tries to find its independence from the policy furor.

The losses sustained by global equity markets in the first quarter were seen as an overdue pause after 2017’s calm rally.  There was an element of ’sell the fact’ following the eventual introduction of broad tax cuts in the US, but the underlying economic tone was positive. Signs of policy misguidedness were creeping into market banter, which exacerbated the swings, but most felt that fundamentals would win the day come the second quarter and stability would resume. That would presuppose that stability in White House staffing and thinking would do likewise, yet that hasn’t been the case so far in this first week of trading.

By mid-week, the major world indices were solidly in the red, led by the NASDAQ 100 with close to a 2% loss from the end of March.  No surprise that the second worst performer in the index was Amazon, dropping more than 4% to below $1400 a share.  Amidst the groans by those that this stock would have a $2000 print on it this half, let’s not forget it is still up 50% from this time last year.  Likewise, it should be no surprise that Trump is going after Amazon in the public domain given that the company’s existing 5-year contract with the US postal service is up this October and word is that the White House is looking for a 40% increase on average parcel delivery charges to Amazon. That partially explains the 14% drop from the March highs.



Yet, Amazon is just one stock, albeit a big one (third largest in the S&P500). And contributing to the cardboard pile-up around homes isn’t the only thing it does.  International business plus web services accounted for 40% of total revenues in 2017.  No, if you took a poll of investors this past week it wasn’t Amazon that was causing angst, but the threat of a protracted trade war with China (and others that the White House wants to bully).

Following the decision to implement steel and aluminum tariffs, the Trump team proposed levies on $50 billion worth of Chinese goods. If you recall, China’s response to the metal tariffs was an imposition of levies on a paltry $3 billion worth of US products. This disproportionately small move was meant as a warning shot across the White House bow. On Wednesday, Beijing stepped it up several notches with tariffs on $50 billion worth of US goods, covering a wide range of sectors. Officials holding out hope that negotiations can bring the two countries together and avoid the actual implementation of these tariffs, but then Trump suggests an extension to a further $100 billion of Chinese goods. Market participants are clearly rattled.



Ditto for the Federal Reserve which only two weeks ago pushed through another rate hike and maintained a bullish outlook for the economy. Now, there are some officials citing the potential for increased uncertainty from a longer lasting trade spat to work its way through jobs and output. The bond market has become more relaxed in recent weeks alongside the weakness in stocks, though the move lower in yields is lower than what we would normally expect when stock volatility escalates. There are a few possible reasons.

One is simply that financial markets don’t believe this latest episode will not translate into a real trade war.  Given that officials on both sides of the dispute are gesturing towards negotiations that view is supported at least for now. The other is that the risk of Chinese retaliation via US bond liquidations still hangs over the bond market at a time when the US is ramping up its supply of new debt because of higher deficits.  The latter is a financial version of ’mutually assured destruction’, whereby an escalation by the US on Chinese trade restrictions could trigger aggressive bond selling by the Chinese central bank, sending US yields higher and sending a chill through Trump’s goldilocks economy.



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